Franc, SNB & Euro-Peg: Can Swiss Central Bank Maintain Ceiling?

Mixed Swiss franc notesThe Swiss National Bank took an unprecedented step to weaken the franc as it introduced a cap of 1.20 francs per euro back in September 6, 2011. The move followed several years of unsuccessful attempts to devaluate the currency. The announcement immediately met criticism from skeptics who did not believe that such a ceiling is sustainable. Was the intervention successful and, what is even more important, can the central bank to maintain the euro-peg in the future?

The franc slumped after the introduction of the peg, yet it immediately started to rise. The appreciation was very slow, but steady. By the April, the Swissie was trading near the ceiling. In fact, the currency broke through the 1.20 level on April 5. Thomas Jordan, the Chairman of the Governing Board of the Swiss National Bank, explained the event:

Despite SNB offers placed in the trading systems, a few isolated transactions occurred below CHF 1.20 per euro. However, at no time did the best available euro exchange rate in the market fall below the minimum exchange rate of CHF 1.20. Thus, for a short time, what is known as a segmented market could be observed, in which transactions below the best price were concluded. This situation was remedied within very few seconds, however, by means of arbitrage.

Jordan explained that the central bank cannot control unregulated currency markets even though the SNB can trade and influence them through its counterparties, which consist of more than 100 banks. The Swiss central bank remained committed to maintain the cap and, indeed, the franc was not able to breach the ceiling since then.

There was another reason to believe that the peg may be abandoned. Philipp Hildebrand, the previous Chairman of the SNB, resigned from his office after a scandal involving his wife, who was trading supposedly using insider information. Hildebrand was an architect of the euro-peg and there were speculations that the central bank would abandon the ceiling. New Chairman Thomas Jordan was appointed and specialists, who analyzed his behavior said that he is much more bold and prone to interventions that the previous leader of the bank. Indeed, Jordan reiterated a pledge to keep the cap several times, including his statement after the last policy meeting. What is more, he even considers capital controls if the situation with debt in Europe would worsen significantly.

Concerns about global economic growth are mounting, demand for safety rises and Forex market participants are still questioning the sustainability of the peg. Can the SNB keep the ceiling intact? As it usually happens, opinions are divided on this matter.

George Saravelos of Deutsche Bank argues that the central bank “has unlimited firepower to defend the floor”. In fact, quite a few economists think that the SNB would only stop its printing press only when it will deem necessary. Michael Sankowski presented another argument. He thought that the main reason for strength of the franc was outflow of capital from the euro to the Swiss currency. The weakening euro may help economies of the eurozone to become more competitive on global markets, alleviating some of the region’s problems. Consequently, capital may start to flow in opposite direction.

It seems, though, that a vast majority of analysts does not believe in the ability of the SNB to maintain the peg for a long time. Ronald Leven, the Executive Director at Morgan Stanley, was among them. Paul Meggyesi, a currency strategist at JPMorgan Chase, said:

The honeymoon for the SNB is over. We are more comfortable in predicting the ultimate demise of the floor…than in calling the timing of such a shift.

Steen Jakobsen, the Chief Economist at Saxo Bank, provided several reasons for the SNB to drop the cap, including rising inflation, the ability of the Swiss economy to cope with a strong currency and a potential for the intervention to reach 100 percent of Switzerland’s gross domestic product. The deflationary pressure was one of the main reasons for the central bank to introduce the ceiling and as that danger of deflation subsides, so the incentive for the bank to keep the peg. As for the nation’s economy, GDP was rising steadily this year, showing that Switzerland is indeed on track to robust economic growth. That gives support to the opinion that the danger of a strong currency was overestimated. As for the matter of capital controls, most experts think that such measures never proved effective and, besides, the international community is not likely to be pleased with such blatant currency manipulation. There are already many voices that compare Switzerland to China.

So, will the Swiss National Bank to keep the euro-peg? Obviously, it is hard to predict with a 100 percent guarantee. As it was said, most experts believe that the bank would not be able or, indeed, would not want to maintain the cap for a prolonged period. Yet not many analysts dare to predict when exactly the SNB will abandon the ceiling. For now, the central bank remain committed to its strategy, but, at least, stopped speaking about raising the ceiling.